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1.5 Other costs to be considered for capitalization
Publication date: 31 Dec 2022
us PP&E and other assets guide 1.5
As discussed in PPE 1.2, costs to be capitalized for long-lived assets include directly attributable costs that are incurred for the construction or acquisition of the long-lived asset. The treatment of certain types of costs may require judgment. See PPE 1.5.1 for a discussion of the accounting for customer reimbursements, PPE 1.5.2 for pre-production costs, PPE 1.5.3 for spare parts, and PPE 1.5.4 for liquidated damages.
1.5.1 Customer reimbursements (capital projects)
A company may receive up-front cash payments to fund the construction of fixed assets that the company will use to provide products or services to a customer. An example is a reporting entity that enters into an arrangement with an auto manufacturer to design and develop tooling prior to the production of automotive parts in which the reporting entity receives an up-front cash payment for the pre-production costs. A question may arise as to how to account for the up-front cash payment received by the company.
Management should first evaluate whether the reimbursement is consideration received from a customer pursuant to a revenue contract. If so, the reimbursement would be included as part of the transaction price allocated to the distinct goods or services transferred to the customer under the contract. Management would assess whether control of the fixed assets transfers to the customer and if so, whether the fixed assets represent a separate performance obligation in the contract. Refer to the PwC’s Revenue from contracts with customers guide for further discussion on the accounting for arrangements in the scope of the revenue standard.
If the payments are not in the scope of ASC 606, then they would not be recognized as revenue from contracts with customers. Instead, if the up-front payment is nonrefundable, the reporting entity should recognize the payments as a reduction to the cost of constructing the fixed assets. For payments received from a governmental entity, refer to PPE 1.6.
When the nature of a service contract explicitly or implicitly allows the use of an asset to be controlled by a customer, the arrangement should be evaluated for whether it contains an embedded lease. Refer to LG 2 for information on determining when a contract contains a lease.
1.5.2 Pre-production costs
In some industries, various pre-production costs are incurred related to the design and development for molds, dies, and other tools that will be used in producing parts under a long-term supply arrangement. This is common in manufacturing industries in which specific molds or tools are required to produce parts that are specific to a customer’s needs. Specific guidance exists in ASC 340-10 regarding the accounting for pre-production costs related to long-term supply arrangements. Although this scope appears broad, judgment may be required to determine whether this guidance applies to each arrangement based on specific facts and circumstances. Refer to RR 11 for additional information on contract costs.
Design and development costs for products to be sold under long-term supply arrangements shall be expensed as incurred. Design and development costs for molds, dies, and other tools that a supplier will own and that will be used in producing the products under a long-term supply arrangement shall be capitalized as part of the molds, dies, and other tools (subject to an impairment assessment under the Impairment or Disposal of Long-Lived Assets Subsections of Subtopic 360-10) unless the design and development is for molds, dies, and other tools involving new technology, in which case, the costs shall be expensed as incurred in accordance with Subtopic 730-10.
This guidance indicates that design and development costs related to products to be sold should be expensed as incurred, whereas design and development costs related to molds, dies, or other tools that the supplier will own should generally be capitalized, unless they relate to new technology. Costs incurred for new technology that have uncertain future economic benefits should be expensed as incurred. For discussion regarding the accounting for the capitalization of research and development costs, see PPE 8.3.3.
Design and development costs related to tools, molds or dies that a supplier will not own may also be capitalized under certain circumstances.
Design and development costs for molds, dies, and other tools that a supplier will not own and that will be used in producing the products under the long-term supply arrangement shall be capitalized (subject to an impairment assessment under the Impairment or Disposal of Long-Lived Assets Subsections of Subtopic 360-10) if the supply arrangement provides the supplier the noncancelable right (as long as the supplier is performing under the terms of the supply arrangement) to use the molds, dies, and other tools during the supply arrangement. Otherwise, those design and development costs shall be expensed as incurred, including costs incurred prior to the supplier's receiving the noncancelable right to use the molds, dies, and other tools during the supply arrangement.
Excerpt from ASC 340-10-25-3
If a contractual guarantee for reimbursement exists for design and development costs that otherwise would be expensed based on the guidance in this Section, those costs shall be recognized as an asset as incurred.
In order to capitalize pre-production design and development costs, the reporting entity generally should consider whether a long-term supply agreement exists, whether a contractual guarantee of reimbursement for pre-production product design and development costs exists, and whether the amount of reimbursement can be objectively measured and verified.
When evaluating the existence of a contractual guarantee, there should be a legally enforceable agreement in which the amount of reimbursement can be objectively measured and verified. In other words, there is a legal obligation to provide reimbursement.
Objective measurement and verification of the amount of reimbursement can be difficult to assess and requires judgment in many cases, particularly when reimbursement is built into the price paid for each part purchased. Generally, the amount of reimbursement should be clearly defined in the contract, indicating a dollar threshold to which the company will be reimbursed for pre-production design and development costs. Alternatively, contract terms may specify that the company will be reimbursed at a fixed rate per unit of production. In this case, to record an asset, the contract must specify the number of parts to be produced, the dollar reimbursement per part, and the consequence if production is less than the specified number of parts to be produced. Lack of specificity may call into question whether the company can record an asset for such costs. Instances when the amount of reimbursement is not clearly defined or the company has a practice of negotiating a settlement of the reimbursement amount may indicate a lack of a definitive arrangement and as a result, may mean that pre-production design and development costs should be expensed as incurred.
These types of arrangements are very common in some manufacturing industries, including the automotive industry, in which the supplier is responsible for acquiring or building the mold, die, or tool, but will be reimbursed by the customer. In these cases, the design and development costs are generally capitalized by the supplier in accordance with ASC 340-10-25-3, even in circumstances when the customer has the ability to take possession of the tool at the end of the contract term.
1.5.3 Spare parts
Companies often maintain spare parts for machinery to prevent shutdowns on the manufacturing line in the event of equipment failure, which could be time consuming and costly. Spare parts are also held on hand if the lead time to acquire new parts is long or contractual maintenance agreements require that the reporting entity maintain such parts on hand.
Limited US GAAP guidance exists regarding the accounting for spare parts. However, the Airline Guide provides guidance on the accounting for spare parts that is often used by analogy in other industries.
AICPA Audit and Accounting Guide for Airlines
Paragraph 4.131
Spare parts are typically grouped into several broad categories: rotables, repairables, expendables, and materials and supplies. The following table provides brief descriptions of the categories and accounting treatment for each category.
Spare Parts Category |
Accounting Treatment |
Rotable parts typically are significant in value and can be repaired and reused such that they typically have an expected useful life approximately equal to the aircraft they support. |
Rotable parts are capitalized and classified along with flight equipment as fixed assets. Rotable parts are normally depreciated over their useful lives or the remaining service lives of the related equipment. The cost of repairing rotables is charged to expense as it is incurred. |
Repairable parts are repairable and reusable but with economic useful lives generally less than the aircraft they support and values less than most rotable parts. |
The Accounting Standards Executive Committee believes that repairable parts, along with certain life-limited rotable parts, can be classified as either expendables in current assets or as rotables in fixed assets. Repairable parts are normally depreciated over the lesser of their useful lives or the remaining service lives of the related equipment. The cost of repairing repairable parts is charged to expense as it is incurred. |
Expendable parts cannot be economically repaired, reconditioned, or reused after removal from the aircraft. |
Expendable parts are recorded as a current asset and are charged to expense as they are used or consumed in operations (that is, placed on an aircraft). Expendable parts are valued at cost, less an allowance for obsolescence. |
Miscellaneous materials and supplies support flight or ground equipment. |
Miscellaneous materials and supplies are either classified with expendable parts in current assets or are expensed upon purchase. Classification of specific parts ordinarily depends on the carrier's maintenance program. |
Excerpt from AICPA Audit and Accounting Guide for Airlines Paragraph 4.134
Operationally, when a rotable part is installed on an aircraft, the old part is taken off and replaced with a similar part from the pool of rotable parts. The removed unserviceable rotable part is repaired and then placed back in the spare parts pool for use on another aircraft after being made serviceable. The cost to repair the part is expensed as incurred. The aircraft and the related rotable parts continue to be depreciated over their estimated useful life. Until a rotable part is scrapped, it retains its functionality and just moves among various locations and aircrafts.
According to the Airline Guide, spare parts that have significant value, such as spare engines, should generally be capitalized and depreciated over their useful lives or the remaining service lives of the related equipment. Alternatively, some companies consider spare parts as a current asset (e.g., inventory) that are not depreciated, but instead expensed when they are placed in service (similar to maintenance expense). Companies should carefully consider the relevant facts and circumstances associated with their spare parts to determine whether they should be classified as long-lived assets or inventory. The policy should be consistently applied. Refer to FSP 8.6 for additional information related to classification of spare parts.
1.5.4 Liquidated damages (capital projects)
In the event that construction is not completed by an agreed upon date, or if the asset does not meet certain performance or other requirements outlined in the contract, certain construction agreements provide for the payment of liquidated damages by the contractor to the owner of the asset under construction. Liquidated damages are negotiated to represent compensation for a reasonable estimate of the buyer's (owner's) costs associated with a delay or less than expected performance and are usually specified in advance to eliminate the need for subsequent negotiation of actual costs incurred.
Any payments received by the buyer (owner) from the contractor should be presumed to be a reduction of the cost of the asset being constructed. It is generally not appropriate for the buyer of an asset to immediately recognize income for liquidated damages received from the contractor. To the extent liquidated damages are reimbursements of direct and incremental costs incurred by a buyer as a result of the contractor’s breach, and provided that the costs incurred were not capitalized by the buyer, it may in certain circumstances be acceptable to reflect such amounts in the income statement.
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